What is a ‘Barbell’
Barbell is an investment strategy applicable primarily to a fixed-income portfolio, in which half the portfolio is made up of long-term bonds and the other half of very short-term bonds. The “barbell” term is derived from the fact that this investing strategy looks like a barbell, heavily weighted at both ends and with nothing in between.
The barbell strategy in fixed income is the opposite of a “bullet” strategy, in which the portfolio is concentrated in bonds of a particular maturity or duration.
BREAKING DOWN ‘Barbell’
A portfolio manager implementing the barbell will have a portfolio consisting of only short-term bonds and long-term bonds, with no intermediate duration bonds. The barbell strategy attempts to get the best of both worlds by combining low-risk and high-risk assets and getting better risk-adjusted returns in the process. The barbell is an active form of portfolio management, as it requires frequent monitoring since the short-term bonds must be continuously rolled over into other short-term instruments as they mature. As well, the weightings for the bonds or assets on either side of the barbell are not fixed at 50%, but can be adjusted to market conditions as required.
The barbell strategy is also increasingly used with reference to stock portfolios and asset allocation, with half the portfolio anchored in defensive, low-beta sectors or assets, and the other half in aggressive, high-beta sectors or assets.
The traditional notion of the barbell strategy calls for investors to hold very safe fixed income investments on one end of the portfolio, and high-risk securities on the other end. For example, an asset allocation barbell may consist of 50% safe, conservative investments such as money market instruments on one end, and 50% high-beta investments – such as emerging market equities, small- and mid-cap stocks, and commodities – on the other end. If market sentiment is very bullish, as for example at the beginning of a broad rally, the investments at the aggressive end of the barbell will typically perform well. As the rally proceeds and market risk rises, the investor may wish to book gains and trim exposure to the high-beta side of the barbell. The investor would therefore sell, for example, 5% of the high-beta portfolio and allocate the proceeds to the low-beta end, so that the allocation is now 45% (high-beta) to 55% (low-beta).
Barbell strategy advantages include offering better diversification than a bullet approach, and reducing risk while retaining the potential to obtain higher returns. If rates rise, the investor will have the opportunity to reinvest the proceeds of the shorter-term bonds at the higher rate. The short-term securities also provide liquidity for the investor and flexibility to deal with emergencies since they mature frequently.
One drawback of the barbell strategy is that it eschews the middle road, such as intermediate-term bonds in a fixed-income barbell, and medium-risk investments in a stock or asset allocation barbell. This may not be the best course of action at certain times of the economic cycle when intermediate-term bonds and medium-risk investments tend to outperform.